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Why Seoul Is Seething

January 26, 1997

International Business: SOUTH KOREA

WHY SEOUL IS SEETHING

Koreans want the mismanaged chaebol to share the economic pain

They looked so out of place, with their conservative suits and smart haircuts. But there they were, masses of Seoul's bank clerks and middle managers, braving freezing temperatures to march alongside hardened factory hands and voice their outrage at a new labor law. The squadrons of riot police, packed in serried ranks behind menacing shields, made no exceptions for these white-collars. They lobbed the same tear gas at clerks and managers that they used against the workers who have been marching by the hundreds of thousands in Seoul since late December.

Ritual clashes between police and workers are nothing new in Korea. But the participation of middle-class protesters clearly shows something new is afoot. There's a new anger to the protests, anger at a just passed law that makes layoffs possible, a law many Koreans see as a sign of a return to the bad old authoritarian days. But besides anger, there's fear. The protesters sense that Korea's economy and society are changing so rapidly that many cherished parts of life--including lifetime employment and steadily rising wages--will die out. The result is a wave of strikes at dozens of plants that have cost the economy billions in lost production.

The profound crisis highlights the strategic missteps of Seoul's policymakers and the giant corporations known as the chaebol. South Korea became one of Asia's dragons through a heavily regulated, export-driven model that insulated the chaebol from serious competition in their home market. Workers had few rights, but they got lifetime jobs and good raises.

MIRACLE TO MALAISE. Now that mercantilist model is turning the Korean Miracle into the Korean Malaise. Costs are threatening the competitiveness of the chaebol--which are borrowing massively to conquer overseas markets. Yet margins are low in businesses as diverse as autos and semiconductors. And Korea's Asian competitors are muscling into the same turf. The chaebol can no longer afford the price of social peace--high wages at home.

The government's latest effort was a badly fumbled attempt to provide relief to Korean business by driving down labor costs. The law was rammed through parliament by President Kim Young Sam's party on Dec. 26, without opposition members present. The legislation makes it easier to fire employees and hire part-time workers, yet it keeps new unions illegal until 2000.

Even before the protests, problems were piling up in Korea. The Korean stock market has been in a free fall, plummeting 26% last year. What's more, the weak Japanese yen and cyclical price declines have combined to slash prices on Korea's key exports--memory chips, steel, and petrochemicals. Earnings have plunged, and export growth has slowed, rocketing the current-account deficit to $23 billion last year, or a lofty 4.7% of gross domestic product. "We have to build a new economic model," Deputy Prime Minister and Finance Minister Han Seung Soo told BUSINESS WEEK. Korea's growth, which slowed to 6.8% in 1996 from a torrid 9.0% in 1995, may slide to 6.2% this year.

With Korean unemployment benefits in their infancy, workers feel they will be forced to bear all the pain of reform. Their rage is partly justified, but it doesn't change the fact that costs are out of control in Korea. Real wages rose an annual average of 8.2% in the decade through 1995, far outstripping productivity gains, which averaged 6.5%.

While the chaebol want to chop costs at home, they are also shifting investment abroad. The top four chaebol--Hyundai, Samsung, LG, and Daewoo--have been investing billions in the U.S., Europe, Asia, and the old Soviet bloc. Little wonder. Even advanced countries such as Britain offer manufacturing wages up to 30% lower than Korea. The average consumer-electronics factory worker makes $6.94 an hour in Britain, compared with $9.99 in Korea.

Shifting assets will not solve all the chaebol's self-created problems. These family-owned and -managed groups are famous for their autos, electronics, and other capital-intensive businesses. Yet they have diversified into unrelated fields as far-flung as fertilizer and restaurants, undermining their ability to compete in key industries. Chaebol profits remain dangerously dependent on products subject to volatile price trends. The result of diversification has been overcapacity, declining profit margins, and growing dependence on developing markets. "The question is, will we go bankrupt or find a solution?" says Lee Keunmo of ING Barings Ltd.

Previous attempts by President Kim to use tax cuts and other incentives to force the sprawling chaebol to concentrate on core products have been to little avail. The chaebol have only gotten bigger. Sales by the top four conglomerates account for about 80% of Korea's GDP and half of total exports. Affiliated companies of the top 30 chaebol grew from 623 in 1995 to 669 in 1996.

WILD EXPANSION. Some chaebol are trying to slam the brakes on expansion. Samsung Group was hit badly when prices for 16-megabit dynamic random-access memory chips (DRAMs) collapsed from $80 at the end of 1995 to about $10 now--just about the break-even point. Now, says Jee Seung Lim, senior managing director for strategic planning, Samsung plans to halt production of 29 products, such as construction equipment, and stick with things like semiconductors. "We will concentrate on a few selected products in which we can enjoy monopolistic market share," he says.

Many of Korea's problems are similar to Japan's. But unlike its neighbor, it lacks Japan's huge domestic market and technological strengths. Instead of being cash-rich, Korean corporations are highly indebted, with an average debt-to-equity ratio in excess of 200%. "Without massive restructuring, Korea will be the most vulnerable Asian economy to the global deflationary trend of the 1990s," said Rhee Namuh, director of research at Dongbang Peregrine Securities Ltd.

The government has taken a few steps to address the problems. In addition to the labor law, Kim Young Sam plans an advisory committee on financial reform. But with a presidential election in December, prospects for big changes this year are slim. Economists fear political concerns will have the government reverting to old tricks, intervening in the stock market and knocking down interest rates. These moves would stoke inflation, projected at 4.8% this year. "Political considerations will make things worse. Then we'll need a bigger adjustment in the future," says Kang Ho Sang, professor of international business at Sogang University in Seoul.

MORE KICKBACKS. Only full financial deregulation will root out red tape and cronyism and instill a new competitive attitude. Here again, the political challenge is daunting. Korea's Finance Ministry is a powerful institution staffed by career employees loath to surrender their power to market forces. "We need drastic reform, but lower-level officials want to monopolize the process," says Finance Minister Han. Few Korean bureaucrats have the expertise to monitor sophisticated financial markets. A survey by Korea's leading newspaper found that 80% of 119 foreign executives cited bureaucrats as the biggest barrier to doing business in Korea. "As long as the red tape remains, corruption will persist," says the manager of a small venture-capital firm. "The kickbacks that some bureaucrats demand have only gone up."

Korea's growth will grind inexorably lower unless the formula is fundamentally changed. President Kim, and whoever succeeds him, will have to form a national consensus if Koreans are to go forward together. "We are ready to buckle down and work harder, but management must also face reality," says Kim Doo Ran, an electrical-parts worker in the port city of Inchon. The strikers have shown that authoritarian moves are the wrong way to overhaul the economic system. Now, all Korea must accept the opportunities and challenges of free markets and free politics.By Steven V. Brull and Catherine Keumhyun Lee in SeoulReturn to top